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Deductibility of one-time large contribution to fully fund and terminate DB.


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The CPA of the client asks me for my insight, which I have little of, in this case.  The business owners have been wanting to terminate their DB Plan for some time.  They say if they make a one-time contribution of about $20 million, the DB will be fully funded and then can be terminated.  The business owners ask, what is the tax deductibility of the $20 million contribution?  For example: in the current year?

Thank you,

Ray

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Funny thing.  If our clients asked us questions about tax treatment of a contribution or intended contribution, we would refer them to their tax advisor (i.e., the CPA). 

Assuming that this plan has been in place for a while with essentially the same benefits, the tax deduction limit under IRC Section 404 would usually be something like the amount needed to fund (without the funding relief adjustments to the discount segment rates under HATFA) up to 150% (taking into account the impact of future compensation increases, if any, on benefits attributable to service through the end of the year).  So how does a $20 million contribution line up with that limitation?   Are we talking of a plan with $50 million in assets and a funding liability of $40 million (but projected lump sums/annuity purchase costs of $70 million) with frozen accruals or a plan with $30 million in assets, a funding liability of $40 million and an estimated termination liability of $60 million?

If it's a newer plan or recently liberalized, the limits under IRC Section 404 could be impacted.  The participation limitations under IRC Section 415 could come into play.  Why can't the CPA answer questions like this instead of asking them?

If the money is needed to terminate the plan, there is a reasonable chance that if $20 million more is needed, then it would be deductible.  But the sponsor's tax and legal advisors should, working with the plan's enrolled actuary, be able to determine how close to being true that would be.

Always check with your actuary first!

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Plan assets equal $15,000,000.  Funding target without regard to HATFA relief equals $16,000,000.  Accruals frozen (so no cushion amount related to future compensation increases with respect to prior service and Target Normal Cost = 0).  Annuity purchase costs (perhaps the plan permits lump sums after termination of employment and all of the participants are relatively young) are $35,000,000.  Need another $20,000,000 to get there, but 404(a)(1)(A)(o) limit is $16,000,000 Funding Target plus cushion amount of 50% of $16,000,000 less assets = $9,000,000.

Always check with your actuary first!

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45 minutes ago, Mike Preston said:

What about 404(o)(5)?

Assuming the plan is subject to 4041, guess you have me there.  404(o)(5) is not a section one works with every day (certainly not one that comes into play unless the plan is terminating)!  Even then, it is somewhat hard to find a situation where 404(o)(2) won't get the plan to full funding on a termination basis.

That sort of thing falls more under the purview of the sponsor's CPA/tax advisor than the plan's enrolled actuary. 

Always check with your actuary first!

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Somewhat hard?  I think your example of a funding target of $15x and ultimate plan liabilities of $35x would be very, very difficult to reproduce in the wild.

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Suppose that the average age of the actives is 42 and that there are essentially no terminated or retired participants because of the lump sum option.  The funding target for 404 purposes is based on a discount rate of 4.79% (third segment on a no relief basis) and that you can't find an insurance company willing to sell deferred annuities with an option to cash out at any time after separation from service using an interest rate above 2%.   Unusual but possible.

Always check with your actuary first!

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15 minutes ago, RayJJohnsonJr said:

Would the attached 5500 help?

DB Plan 2015 5500.pdf

With assets around $26 million and a funding target around $28 (on a funding relief basis), the maximum with cushion amount would be at least $16 million, probably more when the funding target for maximum purposes is calculated using non-funding relief rates.  What makes them think they need to put $20 million in to terminate the plan?  That seems high, based on the numbers on the Schedule SB.

Always check with your actuary first!

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18 minutes ago, Mike Preston said:

"Probably" more?

Well, yes, I suppose that "certainly" would be a more suitable word in that context.  It would surprise me, whether or not they needed $20 million more in the fund, if the maximum was not at least $20 million, even with no further accruals.

Always check with your actuary first!

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